THE HEDGEYE MACRO PLAYBOOK

Takeaway:We know we're a little late today (post Hedgeye holiday party edition), but you DO NOT want to miss what we have to say about energy below.

INVESTMENT CONCLUSIONS

Long Ideas/Overweight Recommendations

iShares National AMT-Free Muni Bond ETF (MUB)

iShares 20+ Year Treasury Bond ETF (TLT)

Vanguard Extended Duration Treasury ETF (EDV)

Consumer Staples Select Sector SPDR Fund (XLP)

Health Care Select Sector SPDR Fund (XLV)

Short Ideas/Underweight Recommendations

iShares Russell 2000 ETF (IWM)

iShares MSCI European Monetary Union ETF (EZU)

iShares MSCI France ETF (EWQ)

SPDR S&P Regional Banking ETF (KRE)

SPDR S&P Oil & Gas Exploration & Production ETF (XOP)

QUANT SIGNALS & RESEARCH CONTEXT

#Quad4 Asset Price Deflation in Energy Continues: As my colleague Brian McGough suggested in today’s Early Look, we aren’t perfect and we certainly don’t nail every call that we make. We often miss things, but one of the things we have fortuitously not missed this year is the pervasive deflation across the energy complex.

Even with tools as powerful as our GIP Model, Keith’s TRADE/TREND/TAIL model and TACRM, our asset allocation process remains far from perfect. We do, however, take solace in the fact that perfection does not exist on an ex ante basis in markets. Well, that and the fact that our process is pretty darn good.

Using a combination of quant signals and fundamental data to predict what “Quadrant” we’re in or headed into gives us the best probability to get our asset allocation and sector/style factor rotations right. It is truly the equivalent of perpetually stepping into the batter’s box with 3-and-0 count in hand.

When we started pounding the table on #Quad4 back in early August, reacting to the “3-and-0” count then was to get long of U.S. dollars and [very] short of commodities and commodity-linked equities – energy in particular. That’s probably the best macro call anyone could’ve made in 2H14. Either that or buying the mid-October lows in the stock market.

While we missed making the latter call, we certainly did not miss making the call for asset price deflation in energy. In fact, my colleague and rock star commodities analyst Ben Ryan has been all over this move. Please review the following notes to learn more about why we think crude oil, E&Ps and upstream MLPs have furtherdownside from here:

After yesterday’s -3.3% plunge, domestic E&Ps (XOP) are now down -15.6% WoW and -41.3% from their YTD peak in late June. OAS on high-yield energy bonds have backed up from a YTD low of 402bps to 845bps as of this morning. As we highlighted in our #Bubbles theme, illiquidity and spread risk were the two key factors that perpetuated and continue to perpetuate our negative bias on the broader junk debt market.

One of the hardest things to do as investors is having the guts to stick with a call like this. It’s obviously now extremely consensus; even StreetAccount appears to be bearish on the energy complex per the content of their summary note this morning at ~8:00am:

“Oil drop gives US drillers argument to end export ban: Bloomberg noted that the fall in oil prices has given oil producers a new argument for ending the US ban on exports. The article said with US output at a 31-year high and imports at the lowest level since 1995, producers seeking the best possible price for crude are stuck having to keep sales at home. Removing the ban could erase an imbalance between US and foreign crude prices. It pointed out that lawmakers are set to hold a hearing next week on dropping the ban.”

“Oil reserves at highest since 1975: The FT reported that US proven oil reserves rose to their highest level since 1975 last year. The article noted that proven reserves were in decline up until 2009. According to the EIA, last year US companies produced about 2.7B barrels from their reserves, but added 5.5B in new discoveries. As a result, the US ended 2013 with about 36.5B barrels of proven oil reserves, a 9.3% y/y rise. The peak remains 1970, when proven reserves were reported at 39B barrels.”

“Energy debt may be experiencing 'Minsky Moment': The FT said we may be seeing a "Minsky Moment" with energy and junk bonds, as investors begin to price in the potential end of the boom that funded the US shale revolution. The article said the chase for yield has begun to reverse in the energy debt market. It said currently, nearly a third of speculative-grade debt issuance by energy companies trades so poorly it qualifies as being classed as distressed.”

Sometimes consensus is right and that appears to be the case here. Per our Tactical Asset Class Rotation Model (TACRM), energy related sectors and subsectors continue to head up the rear among the 47 sectors and style factors we track across the U.S. equity market from a Volatility-Adjusted Multi-Duration Momentum indictor (VAMDMI) perspective. Adjusting for volume and volatility affords us the conviction needed to interpret this signal as continued pressure for investors to rotate out of these exposures.

Multi-factor. Multi-duration. With conviction. That is truly the Hedgeye Macro “playbook”.

#Quad4(introduced 10/2/14): Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.

#Bubbles(introduced 10/2/14): The current economic cycle is cresting and the confluence of policy-induced yield-chasing and late-cycle speculation is inflating spread risk across asset classes. The clock is ticking on the value proposition of the latest policy to inflate as the prices many investors are paying for financial assets is significantly higher than the value they are receiving in return.

The Hedgeye Macro Playbook aspires to present investors with the robust quantitative signals, well-researched investment themes and actionable ETF recommendations required to dynamically allocate assets and front-run regime changes across global financial markets. The securities highlighted above represent our top ten investment recommendations based on our active macro themes, which themselves stem from our proprietary four-quadrant Growth/Inflation/Policy (GIP) framework. The securities are ranked according to our calculus of the immediate-term risk/reward of going long or short at the prior closing price, which itself is based on our proprietary analysis of price, volume and volatility trends. Effectively, it is a dynamic ranking of the order in which we’d buy or sell the securities today.

EVENTS

Today's Headline Story

RCL– Celebrity Cruises has ordered two EDGE Class cruise ships from STX France for 1.2 billion euros (US$1.49 billion). The 1st vessel will be delivered in Fall 2018 and the 2nd vessel in early 2020. The two new vessels will hold up to 2,900 passengers and be 117,000 gross tons.

Based upon current ship orders, projected capital expenditures for full year 2014, 2015, 2016, 2017 and 2018 are $1.4B, $1.5B, $2.3B, $0.4B and $2.2B, respectively.

Capacity increases for 2014, 2015, 2016, 2017 and 2018 are expected to be 2.4%, 5.5%, 6.7%, 3.8% and 4.3%, respectively.

Takeaway: At $257k per berth, the cost of the two new ships is on par with that of Celebrity Reflection which made its debut in 2012.

Moderate capacity growth has been a strategic goal for Celebrity, particularly after the sale of Century. The premium cruiser has been resilient but the battle for their dollars will be much more competitive in the years ahead.

COMPANY NEWS

MGM– MGM China Holdings Ltd’s co-chairman, Pansy Ho Chiu King, has said the slump in gaming revenue is simply a sign of a tendency toward slower growth after a decade of rapid expansion. “We don’t think that this presents a very pessimistic picture. It now presents a slowing trend” said Ho. She said casinos ought to respond by holding more attractive events and by getting their customers from a wider range of sources.

“The visa restrictions imposed on mainland visitors has added to the gaming industry’s operational pressure, and in the short term it is not easy to introduce new client sources,” Ho added.

NCLH– The first floating Jimmy Buffett's Margaritaville restaurant and 5 O'Clock Somewhere Bar will be aboard Norwegian Escape. Along with the venues on Norwegian Escape, the partnership includes Margaritaville branded food and beverage locations on Harvest Caye, set to open in fall 2015 and a 5 O'Clock Somewhere Bar on Great Stirrup Cay, planned to also debut in 2015. In the future, the partnership will extend to other ships in the fleet. Norwegian Escape will begin weekly year-round cruises from PortMiami to the eastern Caribbean on Nov. 14 next year.

INDUSTRY NEWS

Philippines typhoon– Millions of people in the Philippines began seeking shelter in churches, schools and other makeshift evacuation centres on Friday as Typhoon Hagupit bore down on the disaster-weary nation. The storm, which would be the strongest to hit the Southeast Asian archipelago this year, is expected to impact more than half the nation including communities devastated by Super Typhoon Haiyan last year. Authorities said more than 500,000 families, or about 2.5 million people, in the eastern Philippines would be evacuated ahead of Hagupit's expected landfall on Saturday night or Sunday.

Takeaway: With Japan likely dead, Korea may be the next Asian opportunity.

MACRO

Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway: European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015. Following CCL's F3Q 2014 earnings release, we recently turned negative on those stocks based on the negative European thesis.

Hedgeye Macro Team remains negative on consumer spending and believes in muted inflation, a Quad4 set-up. Following a great call on rising housing prices, the Hedgeye Macro/Financials team is decidedly less positive.

Takeaway: We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.

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12/05/14 09:24 AM EST

USD, Oil and the UST 10YR

Client Talking Points

USD

The risk range for the U.S. Dollar is now 87.64 to 89.21. The good jobs number is good for the USD, the USD has been well bid for 6 months and we don’t think that will change today.

OIL

On the other side of a good jobs number and up U.S. Dollar is down oil. Europe's redo of the central planning messaging puts #deflation right back into Energy markets. The risk range for WTI Crude is 62.99 to 70.64.

UST 10YR

Deflationary forces vs. people thinking that the jobs market is back is most definitely what people in the bond market are going to have to debate today. Bond yields should go up today - just one of the many buying opportunities in $TLT this year.

Asset Allocation

CASH

63%

US EQUITIES

0%

INTL EQUITIES

0%

COMMODITIES

0%

FIXED INCOME

31%

INTL CURRENCIES

6%

Top Long Ideas

Company

Ticker

Sector

Duration

EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).

XLP

The U.S. is in Quad #4 on our GIP (Growth/Inflation/Policy) model, which suggests that both economic growth and reported inflation are slowing domestically. As far as the eye can see in a falling interest rate environment, we think you should increase your exposure to slow-growth, yield-chasing trade and remain long of defensive assets like long-term treasuries and Consumer Staples (XLP) – which work decidedly better than Utilities in Quad #4. Consumer Staples is as good as any place to hide as the world clamors for low-beta-big-cap-liquidity.

Three for the Road

TWEET OF THE DAY

2/3 of Americans in a recession, and Old Wall Media continues to gloat that things are awesome

@KeithMcCullough

QUOTE OF THE DAY

Let him who would enjoy a good future waste none of his present.

-Roger Babson

STAT OF THE DAY

15, the number of animals a lion usually kills a year.

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

December 5, 2014

BULLISH TRENDS

BEARISH TRENDS

CHART OF THE DAY: The #OldWall Model vs. Hedgeye

Editor's note: The chart above and brief excerpt below is from today's Morning Newsletter written by Managing Director and Retail Sector Head Brian McGough.

Before understanding how we generate ideas, it is important to understand the structure that allows us to do what we do – on a repeatable basis. Consider the table below. I compared an OldWall model against Hedgeye on some key operating metrics. The #OldWall could be your typical bulge bracket ibank, a regional research firm, or pretty much anyone else who is in the business of selling research. Let’s compare and contrast…

The 3 and 0 Count

This week I had the pleasure of presenting the state of Hedgeye’s Research engine to nearly 60 of my colleagues throughout our Firm. There were about a dozen key conclusions, followed by a spirited dialogue (which is part of our DNA). But there was one key component of our discussion that I believe is relevant to not only our own team internally, but also to our customers, without whom Hedgeye would not have had such a banner year in 2014. That component is how our business model is structurally different, and how it allows us to think, act, and produce money-making ideas in ways that are dramatically different from the #OldWall.

The Model: WallStreet2.0

Before understanding how we generate ideas, it is important to understand the structure that allows us to do what we do – on a repeatable basis. Consider the table below. I compared an OldWall model against Hedgeye on some key operating metrics. The #OldWall could be your typical bulge bracket ibank, a regional research firm, or pretty much anyone else who is in the business of selling research. Let’s compare and contrast…

1) Stocks Covered: A typical #OldWall analyst will have a fixed coverage universe between 12 and 18 stocks. It takes an average of one month per company to ‘initiate coverage’ on a new name (been there, done that). If you ask that person about a name on the fringe of their coverage, they’ll likely answer “sorry, I don’t cover that”. They’re not allowed to have an opinion without an ‘official’ rating. Note: if an analyst at a Hedge Fund told his/her PM that “I don’t cover that”, they’d soon be out of a job. At Hedgeye, the typical Sector Head has about 100 names under coverage. In Retail, the sector I have the privilege of covering, there’s about 130 names I track regularly. No one at Hedgeye will ever utter the words ‘I don’t cover that’. They might say something like “I’m not familiar with it right now – can I get back to you in a day?” But “I don’t cover it” is not in our vernacular.

Does that mean that I have a ‘call’ on 130 names? Absolutely not. But I have a tremendous playing field from which to source big ideas. I hold myself responsible – as do the other Sector Heads at Hedgeye – to have a repeatable process in place to consistently fish where the fish are. By the time a company works its way through our vetting process, we’ve checked enough risk management boxes such that it’s like a batter stepping up to the plate with a 3 and 0 count. Chances are grossly in favor of that player getting to first base – at a minimum.

2) Big Calls: The way I see it, if I can’t find at least three big longs and three big shorts at any given time out of a group of 130 stocks, then I don’t deserve my seat. Plain and simple. If I were to look at those 130 charts (which I do every weekend) I can assure you that there’s a heck of a lot more than three names that doubled last year, and three that got cut in half.

Let’s add another dimension to the concept of a Big Call. Actually, let’s add two more. Now I’m talking Keith’s language -- TRADE, TREND and TAIL. We’re asked so often why we don’t have ratings. The answer is that the concept of a ‘rating system’ is broken. What if there is a name that we think will double in 18 months, but is going to miss the upcoming quarter by 20%? It might be a short for a more nimble investor, or a long for someone with a 3-year duration that looks through quarterly earnings oscillations (admittedly not many of those people exist, but you get the point). It’s our job to help customers navigate the duration curve.

3) Percent Short: Roughly half of our calls are short. And I’m not just talking about TRADE positions. Each of our Sector Heads has about half of their respective calls on the short side. Heck, our Energy and Internet Analysts have nothing BUT shorts – and they have an enviable track record (check out Kaiser’s call on LINE). The reason why I note in the table above that 0% of Sell-Side calls are Short is that I have yet to see an #OldWall report that actually uses the word ‘short’. About 10% of ratings in an informal check were either Sell or Underweight. But none made an outright short call, and the average price decline was only 5% (which is hardly shortable in today's liquidity environment).

4) Expected Return: The average expected upside for Buy ratings on the Sell side is about 12% for Retailers. If I’m investing real money, I’m probably not going to get too excited about something that gives me a 12% return, unless there is zero potential for downside (which is impossible). In my little world, I’d point out Restoration Hardware, which is a name we’ve liked since $32 (it’s $84 today), and we still think it’s a winner. For those that like it on the sell side, the debate seems to be whether it will be a $90 stock or a $100 stock. From where I sit, the bigger question is whether it is a $200 vs $300 stock. Will it get there tomorrow? No. But by 2018 I think RH will earn $11/share. The consensus is at about $6. It looks expensive today if you believe the Street. But it’s extremely cheap if I’m right. I can guarantee you that if I were at my former (sell side) employer, I literally would not have been allowed to go out with estimates and a resulting equity value that was so far outside of the mean.

One of the inherent challenges to having such a broad coverage approach is that we’ll miss some big moves. With a list of 130 stocks, I can guarantee I’ll miss some big longs and shorts in 2015. I’m not happy about that one bit, but as long as I’m right on the names I pick and help our customers make money, then that’s a win from where I sit. As long as we stick to our process and keep stepping up to the plate with a 3-0 count, I’m downright excited about what 2015 has in store.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 2.16-2.30%

SPX 2037-2079

RUT 1148-1190

Nikkei 16,098-17,930

VIX 11.71-14.38

WTI Oil 62.99-70.64

Get on base,

Brian McGough

Managing Director and Retail Sector Head

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